Did Bernanke Bluff About QE3?

The markets roared from June to September, ever Fed mouthpiece Jon Hilsenrath of the WSJ penned an article calling for more QE in June. Fast-forward to mid-September and the Fed did indeed announce QE3, a plan that will see the Fed monetize $40 billion worth of Mortgage Backed Securities in addition to its plans to Twist $45 billion worth of Treasuries per month: a total monetization scheme of $85 billion.

However, since that time, the Fed’s balance sheet has increased just $3 billion.

Now, it takes several weeks for MBS transactions to settle, so the Fed will announce its MBS purchases since QE 3 started today at 2PM. But if that number is lower than $37 billion (how much the Fed should have bought in the last four weeks) then the Fed lied about QE 3.

In addition to this development, I want to draw your attention to the fact that the Fed balance sheet is DOWN $50 billion year over year. This confirms that the Fed has in fact been engaging in mostly verbal intervention over the last year rather than actual monetary intervention.

The implications of this are of major import.

For one thing, it indicates that the market rally on hopes of more Fed juice is in fact based on a myth. The primary driver of all stock moves has been based on hopes of more liquidity from the Fed and other Central Banks. But the Fed’s balance sheet indicates that this hope is not based on fact. That does not bode well for the bulls.

A second implication concerns the multi-trillion Dollar question: whether the Fed has in fact used up its gunpowder with all of its monetary schemes. After all, the market is roughly break-even since the Fed announced QE 3. Could it be that the market is no longer reacting to Fed action?

If that is the case, then the Bernanke put is over.

These are items to be watching for. We’ll find out the details of the Fed’s actions in an hour or so. But the tide may in fact be turning regarding the success of the Fed’s actions in pushing stocks higher.

For more market commentary, investment ideas and FREE Special Reports on how to profit from the market… swing by www.gainspainscapital.com

Comment viewing options

Graham, I'm trying to figure this out. The FRBNY reports that it's OMO desk has purchased $71.5B of MBS since QE3 began, all for future settlement. I was puzzled by the stasis of the Fed's balance sheet, which I now understand to be due to future setttlement of MBS. So am I correct that the Fed has grown its balance sheet and the monetary base by $71.5B between 9/12 and 10/10 due to QE3?

Effective January 1, 2011, as a result of the accounting policy change, on a daily basis each Federal Reserve Bank will adjust the balance in its surplus account to equate surplus with capital paid-in and, in addition, will adjust its liability for the distribution of residual earnings to the U.S. Treasury. Previously these adjustments were made only at year-end. Adjusting the surplus account balance and the liability for the distribution of residual earnings to the U.S. Treasury is consistent with the existing requirement for daily accrual of many other items that appear in the Board’s H.4.1 statistical release. The liability for the distribution of residual earnings to the U.S. Treasury will be reported as “Interest on Federal Reserve notes due to U.S. Treasury” on table 10. Previously, the amount necessary to equate surplus with capital paid-in and the amount of the liability for the distribution of residual earnings to the U.S. Treasury were included in “Other capital accounts” in table 9 and in “Other capital” in table 10.

Some explaining is needed, and we’re indebted to Bank of America Merrill Lynch’s US rates team — Ralph Axel, Priya Misra and Brian Smedley — for their help with this.

An accounting explainer

Since 1947, the Fed has been required to send, or remit, most of its profits to the US Treasury, as opposed to using them to build up its own capital. These remittances are roughly equal to income from the Fed’s loans and securities holdings minus operating expenses and stuff like interest paid on reserves, dividends paid to member banks and — ahem — any amount needed to top-up the Fed’s own capital (paid-in capital).

These remittance payments have surged in recent years — along with the Fed’s unconventional policy measures and balance sheet. Indeed, that puffed-up balance sheet is the thing causing people to worry about potential losses to the central bank, especially if short-term interest rates were to rise enough so that interest paid on bank reserves exceeded the Fed’s interest income from its Soma portfolio (where it keeps the US Treasuries and Mortgage-Backed Securities bought as part of its unconventional policy measures). Or, more basically, the Fed could incur losses if it just started selling securities below their original purchase price.

Before the above accounting change, any unremitted earnings that were due from the Fed to the US Treasury would accrue in that ‘other capital’ account. Now however, they’ll be shown in a separate liability item called ‘interest on Federal Reserve notes due to US Treasury.’ So instead of any future Fed losses showing up as a reduction in Fed capital (‘other capital’) — they’ll now show up as negative interest due to the US Treasury.

Kindof find it hard to believe that Bernanke would announce the purchase of $50B per month of MBS, then not buy them. It seems more likely to me that their balance sheet was "cleaned" and debt was offloaded somewhere else that is hard to see (sneaky bastards), to make room for much more in the coming years. Probably a new MO for them.

yes because audting the balance sheet will make people start caring that the banks were bailed out and immediately after gave out record bonuses. you think that there is a day when ron paul holds up the Fed balance sheet and says SEE and then everyone starts caring. wrong. there are plenty of people who want the fed to hand money out like that.